In a highly complex equity and debt transaction for Allianz, JP Morgan reworked instruments called Miles to devise a more flexible way for the insurer to deleverage its unwanted equity holdings. As Edward Russell-Walling reports, the solution was found when the two firms put their heads together.

Holidaymakers take note: the island of Mauritius has a highly efficient mobile communications network. While this proved extremely helpful to JP Morgan in the crucial design stages of a complex equity and debt transaction for Allianz, for Viswas Raghavan, the bank’s team leader and head of equity and equity-linked capital markets, it meant a less than relaxing Christmas holiday.

Christmas 2004 was a fairly hectic time for anyone who worked on this extraordinary deal, which interlaced an equity-linked exchangeable bond, a mandatory exchangeable note, a straight equity placement and a hybrid capital issue – all on the keenest of terms and without blasting a hole in the German insurer’s share price.

No single element was revolutionary in itself, but the transaction led to certain weaknesses in earlier structures being strengthened.

Many goals scored

Apart from satisfying all its funding needs for the year in a single €4bn swoop in January, Allianz achieved a number of other objectives. One was to repay €2.7bn of senior debt in the current year, but chief among them was to lighten its load of unwanted equity holdings. In the German way, Allianz and its Dresdner Bank subsidiary have amassed significant stakes over time in other German enterprises. This did its share price no favours during the recent equity slump.

Allianz established a model for equity deleverage in 2000, with instruments called Miles (market index-linked exchange securities). These were notes linked to Frankfurt’s DAX index, exchangeable into one or more stocks at the issuer’s option. They carried a coupon of 1.25% (termed an “outperformance premium”, for tax reasons) and a 3.5% settlement discount in the event of exchange.

That issue was led by UBS. Allianz liked it enough to ask JP Morgan, in late 2004, to put together a similar structure.

Inflexible collateral

Mr Raghavan analysed the situation with Carl Bauer, head of JP Morgan’s European insurance group, Allianz client banker Monika Weiler, vice-president equity-linked origination, and Allianz head of corporate finance Stephan Theissing. They realised that if Miles had a flaw, it lay in the structure of the over-collateral. Miles notes were exchangeable into E.ON, BASF or Munich Re shares, with the option of another seven deliverable stocks if the first three underperformed. “But that meant locking up 10 stocks for the duration of the Miles, exposing Allianz to the vagaries of the market, for the remote possibility of an over-collateralisation call,” says Mr Raghavan. “As collateral, it was not the most flexible.”

The next-generation structure that JP Morgan developed is called Bites (basket index-tracking equity-linked securities). These are three-year notes, once again linked to the DAX index and exchangeable this time into Allianz’s holdings of BMW, Munich Re or Siemens shares. The coupon is a rather more advantageous 0.75% and the settlement discount is 1.75%.

Bites work like this: if, on the day of issue, the DAX index stood at, say, 100, then the Bites issue price would be 100. If the DAX has fallen to 50 at redemption, then the holder is owed 50, having received a coupon based on the DAX in the interim.

“Say Siemens shares have doubled in price and the DAX is up 5%,” Mr Raghavan suggests as an example. “Allianz can, technically, call the Bites and settle in Siemens shares. It gives them the ability to exploit any relative performance gains between the stocks and the index. So if Siemens does well, Allianz can use a more valuable asset to settle a lower-performing index.”

Similar design

Miles were designed in the same way. The Bites over-collateralisation back-up looks rather different, however. The first idea was to use cash raised, if needed, through the sale of Allianz treasury shares that were held by Dresdner. “These were consuming capital,” says Mr Raghavan.

The team realised, however, that this would replicate the Miles problem by tying up the stock for three years. “The question was how to get the treasury shares out without prejudicing the deleveraging treatment of the Bites,” Mr Raghavan says. The solution, which was being hammered out during his Mauritian holiday, added another layer of complexity to the deal.

The final structure of the transaction – dubbed “All-in-one” – looked like this: Allianz has issued €1.26bn of Bites to the market. Dresdner has “got out” of the treasury stock by selling it to JP Morgan. JP Morgan has in turn issued €1.55bn of notes, mandatorily exchangeable into the treasury stock.

Price improvement

Allianz will enjoy a share of any price improvement in this treasury stock over the next three years. It gets all of the first 20% above the issue price of €90.5 and a further 17% share of any upside above that. “Allianz has sold the stock, but it is bullish on its future share price,” Mr Raghavan says. “So it has bought the upside from us. In return, it has paid for the call spread, and that call spread is passed through as the coupon on the mandatory.”

Two weeks after the issue, Allianz shares had already gained 5%, so the insurer’s optimism appears justified.

All this was accompanied by an €800m equity placement of Allianz shares, to account for the delta of the mandatory exchangeables on behalf of investors who chose to be fully hedged. In yet another phase of this complicated transaction, Dresdner Kleinwort Wasserstein led a €1.4bn perpetual, non-call 12-year subordinated bond issue with warrants attached. The warrants, however, have been stripped out and are held towards the over-collateral required for the Bites. This over-collateral was key to the deal because it means that the Bites will not count as debt for rating purposes.

As Mr Bauer points out, Allianz has thus achieved a multiplicity of goals. “The €1.2bn of Bites gives them deleveraging funding at sub-Libor rates,” says Mr Bauer. The 0.75% achieved compares with an original marketing range of 0.875%-1.25%, which shows how sought-after this deal was. The settlement discount, ending at 1.75%, began at 2%-2.5%.

“Another goal was to reduce their overall equity exposure, thereby releasing capital,” Mr Bauer continues. “A third was to participate in the upside of their shares, despite having sold them. They have also sent a bullish signal to the market, that they are confident that their share price will go up – and it has.

Tricky plumbing

“The subordinated bond issue gives them soft, hybrid capital, while the warrants underpin the Bites, making up for the over-collateral gap left by the sale of the treasury shares.” Mr Raghavan says that the plumbing was the difficult part. “The securities are not particularly complex in themselves but tying all the ends together was hard work for the team.”

Given the extreme complexity of the deal, it is remarkable that JP Morgan was able to close the book by lunchtime on launch day, and that Allianz stock fell by a mere 1.6% in response. “It helped that we were doing it by ourselves,” Mr Raghavan admits. “There was none of the noise or conflicting messages that multiple bookrunners could have generated.”

Even so, he was up most of the night before, briefing the sales team captains, with the rest of sales and research reporting at 5.45am for an intensive induction session. Both he and Mr Bauer agree that succeeding with a transaction of this nature would have been unlikely without a special kind of client. The JP Morgan team, helped by its investment banking head, Klaus Diederichs, worked side by side with Mr Theissing and Allianz CFO Paul Achleitner.

“The client is one of the savviest issuers in Europe,” says Mr Bauer. “Its finance and treasury team is top class in terms of intellectual prowess and this was a classic example of client and adviser working together to come up with a solution.”

As Mr Raghavan concludes: “The best ideas never happen in a vacuum.”

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter